Mergers and acquisitions in the new
era of Companies Act, 2013
February 2014
Foreword
The new Companies Act, 2013 has sought to streamline and make M&A more smooth and
transparent. It appears that the New Act can help to deal with the challenges and complexities that
the current procedures faces in relation to procedures that were contemplated under the old Act.
The New Act has incorporated various provisions to tackles the problems actually faced during the
process of mergers, by taking into consideration the practical aspects of the process. The newly
added provisions have made it easier for companies to implement ‘Schemes of Arrangement’
(Mergers & Acquisitions, de-merger, corporate debt restructuring etc) and at the same time impose
checks & balances to prevent abuse of these provisions.
It is an attempt to fine tune the process by making it more efficient and in-tune effective. The new
law allows an Indian company to merge with a foreign company, making cross-border mergers and
acquisitions easier. The new law also disallows reverse merger of a listed company with that of an
unlisted one. The New Act no doubt has some ambiguities attached to it, which would need to be
sorted out in order to reduce any complexity in the process. It would need to reduce reliance on
rules to be specified later and also ameliorate provisions that contrive other legislations.
Against this backdrop, ASSOCHAM is actively involved in showcasing related programmes to
bring updated knowledge and policy guidelines for the industry and all stakeholders. ASSOCHAM,
jointly with Ernst & Young LLP is bringing out this compilation for the benefit of participants and
practitioners.
I wish all the best and success for the conference and assure that such knowledge based events
shall continue to be held for the benefit of all segments of the industry and commerce.
D.S. Rawat
Secretary General
ASSOCHAM
Being the Chairman of M&A Council of the Associated Chambers of Commerce & Industry of India
(ASSOCHAM), I am delighted to organize the National Conference on “New Mergers & Acquisitions
Era under the Companies Act, 2013”.
There are pragmatic reforms for Merger and Acquisitions under Companies Act, 2013, which could
make merger, acquisitions and restructuring easier for companies. Introduction of novel concepts
fast track merger for Small Companies and Holding and its wholly owned subsidiary Companies,
Cross Border merger (removing the restriction on only transferee company being Indian company)
under this Act are expected to increase internal restructuring and Cross Border restructuring.
Further exit opportunity to the dissenting shareholders is expected to reduce litigation & frivolous
complaint and representation of Income Tax Department, Sectoral Regulators would safeguard their
interest, though at the cost of prolonged process.
This is the first significant change to merger and amalgamations regime in the last six decades,
with the previous Companies Act having been in place since 1956.The Ministry of Corporate Affairs
has also prepare roadmap for Companies Act, 2013 and in this direction in its recent circular given
chance to Income Tax Department and other Sectoral Regulators to make their representation on
Merger and Amalgamation in line with the provision of Companies Act, 2013.
I hope this National Conference gives rich insight and adequate knowledge to all the interested
stakeholders. We shall be happy to receive comments /suggestions of the readers for making our
future endeavors better.
With warm wishes
Pavan Kumar Vijay
Chairman, M & A Council
ASSOCHAM
Managing Director
Corporate Professionals
Corporate law has undergone a radical change with the introduction of the Companies’ Act, 2013
in India during this era of major economic overturns. Pursuant to receiving the final nod from the
President in August 2013, the enactment of the Companies’ Act, 2013 has been a significant
step in the path of adapting with laws suitable for our times. The provisions enacted in the new
legislation bring India at par with its global peers from a corporate law perspective on several fronts.
A bright spot in the history of India’s legislative initiatives, the new Act aims to improve
transparency and accountability in India’s corporate sector. It retains the fundamental provisions of
the earlier Act while incorporating stronger and progressive new provisions.
In the recent past, India’s economy has outperformed the West on its growth and attracted large
inflows of foreign funds. Economists predict that the West will soon begin heading northwards. In
this environment, Indian investors will get significant exposure to global economies. Furthermore,
with opening up of international opportunities, companies can look at scenarios where strategic
alliances take simpler routes, and global consolidation and fund-raising are required. Global
integration and cross-border mergers are now permitted, which is an excellent change from the
earlier environment in which only foreign companies were welcomed in India. The challenges faced
by many corporate organizations in listing their businesses abroad if their entire business value is
housed in India will now be reduced due to cross-border mergers, which will enable them to set up
overseas listing vehicles.
The introduction of Class Action Suits, the concept of arms’ length pricing in related party
transactions, the focus on Corporate Social Responsibility, recognition of inter-se shareholder
rights, opening of doors to outbound mergers, fast-track mergers, an increased focus on
governance and protection of minority shareholders are important initiatives for organizations to
move toward global best practices. This paper elaborates on the key provisions of the corporate law
affecting mergers and acquisitions.
The new Act prescribes rules for implementation of its provisions. However, the Rules are at the
draft stage at present. It is hoped their implementation will help Indian corporate laws achieve
parity with international ones and smoothen the transition from the Companies Act, 1956 to the
Companies Act, 2013. It will also help organizations gauge whether Indian corporate laws are
focusing northwards.
I wish to acknowledge the contribution made by my EY tax colleagues and their untiring efforts in
preparing an extensive in-depth comprehensive study on this subject.
We hope this booklet will provide relevant insights and adequate knowledge to all stakeholders in
the M&A arena and we wish the conference great success.
Amrish Shah
Partner and Transaction Tax Leader
EY
Table of contents
2
Companies Act 2013: M&A landscape
18 12 6
Companies Act 2013: impact on transactions
Companies Act 2013: mergers, compromises and arrangements
Companies Act 2013: capital structuring and other
M&A related aspects
Chapter 1
2
Companies Act 2013:
M&A landscape
Mergers and acquisitions in the new era of Companies Act, 2013
The Companies Act, 1956 had almost reached its retirement
age after having been in existence for more than five-and-ahalf decades. It was essential that robust and young corporate
laws were introduced in the system. This journey began in
2008, when the Companies Bill, 2008 was first introduced in
the Lok Sabha. However, it hit a road-block on its introduction
in August 2008 and had to be withdrawn due to dissolution
of the Lok Sabha. The Bill was re-introduced in Parliament
in 2009 and was subsequently sent to the Standing Finance
Committee. After considerable deliberation with stakeholders,
the Committee presented its report to the Lok Sabha in
August 2010. Taking into consideration the recommendations
of the report, a revised version of the Bill was again referred to
the Committee in 2011 with the inclusion of certain
new provisions.
The Bill was passed by both the houses of Parliament between
December 2012 and August 2013. The President signed on
the dotted line on 29 August 2013, providing his much awaited
consent to the 29 chapters, 470 clauses and 7 schedules
comprising the Companies’ Act, 2013. This marked a landmark
event in the history of Indian corporate law.
The Ministry of Corporate Affairs has opted for phased
transition from the Companies Act, 1956 to the new
legislation. As on date, 98 sections of the new Act have been
enacted. Provisions relating to these sections replace erstwhile
legislation, while those of the Companies Act, 1956 are still
in effect for the non-notified sections. However, it is pertinent
to note that implementation of a significant portion of the
provisions of the new Act will depend on its prescribed rules,
which are yet to be formalized. We expect these to be finalized
in the next few months.
The much needed new Act will make acquisitions, certain
mergers and restructuring easier for companies, empower
private equity investors to enforce various restrictions in
agreements and check the malpractices of promoters by
increasing transparency in their operations. The Act also has
the potential to trigger a spate of domestic and cross-border
mergers and acquisitions, and make Indian organizations more
attractive to investors.
Keeping all this in perspective, we seek to provide a “sneak
peek” into the key provisions of the Companies Act, 2013,
which could have a bearing on mergers and acquisitions.
The new Act proposes that the National Company Law Tribunal
(NCLT) will assume the jurisdiction of High Courts in context
of restructuring schemes. We need to wait and watch how
this transpires in coming days. However, a commendable
step in the direction of simplifying courts’ approved merger /
amalgamation/compromise processes include relaxation of
mandates in the case of mergers of small enterprises, holding
companies and their wholly owned subsidiaries, etc., where the
approval of NCLT will not be required. This liberalization will ease
the burden of regulatory authorities and do away with lengthy
implementation timelines, especially in these times when a
strengthened focus on business is the key.
The minimum thresholds of 10% and 5% for shareholders and
creditors objections, respectively, are expected to eliminate the
frivolous objections of small shareholders who oppose deals
under the guise of shareholder activism. Meetings of creditors
may be dispensed with if 90% of creditors (in value) give their
consent to this. This amendment is welcome in view of courts
being inconsistent on the matter of dispensation of meetings for
creditors. However, the need for affidavits may become onerous.
While SEBI has introduced provisions to regulate the accounting
treatment for listed companies, the new Act also brings the
accounting treatment of unlisted ones under the radar of the
regulatory authorities. The NCLT cannot sanction a scheme
unless a certificate from the auditor is submitted, stating
that the accounting treatment is correct. In this scenario,
there ought to be reduced accounting flexibility in the case of
unlisted companies, pursuant to a scheme of arrangement. This
requirement for an auditor’s certificate is also extended to the
capital-reduction process.
Similarly, while SEBI has introduced the concept of e-voting
for listed companies as a part of its modernization process,
the Companies Act, 2013 has extended this to unlisted
companies as well. This is expected to increase the participation
of shareholders and creditors in arrangements, and thereby
protect the rights of all stakeholders.
The law also provides that notice of every scheme should be
sent to various interested regulatory authorities such as the
RBI, the CCI and the Income Tax department, requesting their
representation. This would have an impact on timelines and
could increase attention paid and scrutiny by the authorities.
The new provisions also require that a copy of the valuation
report is annexed to the notice sent to shareholders and
creditors for meetings. Thereby,, the Companies Act, 2013
aims to protect shareholders’ rights and enable increased
scrutiny of schemes by the concerned regulators. It also aims to
increase transparency and reduce the scope for unconventional
practices, particularly where valuation and accounting
considerations are involved.
The merger of a listed company into an unlisted one will allow
the latter to remain unlisted, as long as the shareholders of
the merging listed company are offered an exit opportunity.
Whether such an option could be explored as an alternative to or
in addition to the Delisting Guidelines is a matter that needs to
Mergers and acquisitions in the new era of Companies Act, 2013
3
be appropriately addressed. Payment of the value of shares and
other benefits needs to be in accordance with pre-determined
price formulae or according to their prescribed valuation. This
can be a welcome step if other regulations are aligned with it.
Pooling of assets under a single company in any jurisdiction is
achievable. Global integration and cross-border mergers are now
permitted — the older law only welcomed foreign companies into
India. However, a foreign company must be based in a notified
jurisdiction. This makes it possible for an Indian company to
restructure its shareholdings and migrate its ownership to an
international holding structure, and thereby increase its access
to foreign markets. However, the extent to which this provision
will be beneficial will depend on which jurisdictions are notified
for cross-border mergers under the Act. Furthermore, other
regulations such as the Foreign Exchange Management Act and
the Income Tax Act will need to be in tune with this provision to
make it practically feasible.
Currently, companies are not prohibited from holding treasury
stock. Companies are utilizing such treasury stock to control
their voting rights and manage their cash flows due to this
relaxation. On account of a merger or compromise under the
new legislation, no company can hold shares in the names of
trusts, either on its own behalf or of its subsidiaries. The new
legislation may have been introduced to negate the advantage
available to a company to indirectly hold shares to provide it
access to voting power and/or liquidity. This is in sync with the
motive of the new legislation to enable increased transparency
and accountability in the corporate sector, but could be “hit” in
genuine cases of acquisition, followed by mergers, due to writing
off of goodwill on account of the “Pooling of Interest” method of
accounting required to be followed in such cases.
Investors will now be better empowered to enforce agreed on
rights on specific matters by the inclusion of entrenchment
provisions in Articles of Association. Furthermore, the law
also provides for legality of inter-se shareholder arrangements
relating to transfer of shares. This constitutes a “red carpet”
welcome for private equity investors, who were until now facing
difficulties in enforcing strict conditions in their agreements with
promoters. They will be able to use clauses such as “tag along”
and “drag along,” mentioned in the shareholder agreement.
SEBI and RBI have implemented some welcome amendments,
enabling such rights, to be in sync with the provisions of the
Companies’ Ac t, 2013.
The corporate world currently finds “minority squeeze out” a
challenging task to practically implement due to the stringent
or ambiguous norms that apply to voluntary squeeze out under
the Companies Act, 1956. Retaining the provisions of voluntary
squeeze out, the new law provides for mandatory minority
squeeze out as well, although with appropriate shareholders’
4
resolutions. Shareholders holding more than 90% of the equity
shares of companies are to notify their intention of buying the
remaining equity shares of minority shareholders. The Act also
provides for timeline- and valuation-related requirements for
purchase of shares from minority shareholders.
A provision, which would find favor with most shareholders,
would be dispensation of the requirement of mandatory transfer
of profits to reserves before declaring dividends. The higher the
dividend pay-out, the happier the investors! Similarly, granting
of general voting rights to preference shareholders, where a
company has defaulted in its pay-out of dividends for more than
two years, would garner strong support.
Private companies in India could issue shares with differential
voting rights without any restrictions under erstwhile corporate
laws. However, the Companies Act, 2013 prescribes certain
conditions such as the past track record and size of the issue of
private companies to issue shares with differential voting rights,
While the corresponding section is currently not notified, it may
be interesting to evaluate the validity and enforceability of the
differential rights attached to shares issued under erstwhile
corporate law, since they were not subject to any restrictions.
The sale or transfer of the whole of an undertaking or
substantially most of it by a company now requires a Special
Resolution, as opposed to an ordinary one under erstwhile laws.
Furthermore, the terms “undertaking” and “substantially whole
of the undertaking” have now been specifically defined in the
new Act, thereby eliminating the ambiguity currently existent
in the laws. The requirement for a special resolution on sale or
transfer of an undertaking now extends to private companies.
This once again underlines the motive for strong corporate
governance brought out by the new Act.
A cooling off period of one year between two buy-backs has
been prescribed, even in the case of shareholder-approved
buybacks, limiting the number of buy -backs for a company.
Repatriation of cash through a buy-back may not always be the
optimal solution with the amendment mentioned above, coupled
with the introduction of Buy-back Tax in Income-tax laws. Such
an amendment could significantly affect the plans of MNCs
looking to repatriate cash. Furthermore, now, even a buy-back
under a scheme of arrangement will need to be compliant with
conditions prescribed under core provisions. This will curb the
loophole exploited by companies under the current law.
Multi-layered companies have become a matter of concern for
regulators and investors. Certain scams were eye-openers, in
which a web of companies comprised the investment vehicles
that made the task of identifying the beneficiaries difficult for
law enforcement agencies. The new Act restricts investments
through more than two layers of investment companies, with
Mergers and acquisitions in the new era of Companies Act, 2013
certain exceptions such as in the case of outbound acquisitions
in which the targets have subsidiaries beyond two layers
or where there are more than two investment companies
to meet statutory requirements. The restrictions of multilayered structures (purely for investment purposes) may pose
an additional hurdle for corporate and investee companies
while raising funds, and they may have to revisit their funding
strategies. The new provisions will bring in transparency
in shareholding and funding structures. However, genuine
corporate structures and business transactions will also be
covered by them, and this may curb the ability of companies
to organize their operations efficiently. Currently, it is also
unclear whether past transactions will need to be restructured
to comply with the new legislations.
The Act brings into perspective other issues such as insider
trading, which has now been put down in black and white, as
compared to its absence in erstwhile corporate laws. Although
SEBI’s rules currently have provisions for insider trading, these
only relate to listed companies. The introduction of provisions
relating to insider trading is a huge step in the right direction
in protecting shareholders’ interest. However, at the same
time, there is a need to analyze how this will affect sharing of
non-public price-sensitive information by the management of
unlisted investee companies with potential investors during
their due diligence processes.
In line with its theme of fairness in thought and conduct, the
new Act requires any preferential allotment of capital being
made by a company to be fairly valued by a registered valuer.
This will ensure that existing shareholders are not diluted on a
non-fair basis.
In the Act’s effort to give an increased impetus to corporate
governance, restrictions relating to inter-corporate loans/
investments/guarantees are now also imposed on private
companies and holding subsidiary relationships. Such
provisions may create operational hindrances in genuine
business cases.
Additionally, related party transactions now need to be
undertaken at arms’ length by companies. Related parties and
related party transactions have been specifically defined in
the new regulations. In the event a related party transaction
is not at arms’ length and exceeds the specified amount,
the company requires the consent of its board of directors
and shareholders to undertake such a transaction. However,
irrespective of its arms’ length price, a director’s report of a
company has to disclose each related party transaction and the
justification for entering these. Such provisions largely function
as a watchdog in relation to excessive related party payments
made by organizations and related party transactions that may
hinder the progress of these companies.
The Companies Act, 2013 introduces the concept of class
action suits in India. While there is a threshold on the minimum
number of shareholders or depositors required to initiate such
class action suits, this initiative will enable stakeholders to seek
compensation, not only from a company but also its directors,
auditors and expert advisors for any unlawful or wrong
conduct. This concept has international following and has now
made its presence felt in India. However, its effectiveness will
depend on the manner in which it is implemented.
The Companies Act, 2013 brings about another radical change
in the definition of “subsidiary.” In erstwhile corporate law, a
holding-subsidiary relationship was established between two
companies on the basis of an enterprise’s equity holding in
its subsidiary. According to the new laws, a holding company
and its subsidiary’s relationship is dependent on the former
exercising control over half of the total share capital, which
includes shares other than equity shares. Given this scenario,
the ambit of companies being considered as subsidiaries will
be significantly affected due to which additional compliance
may be required. Furthermore, structuring of investments
vide usage of preference shares also needs to be re-evaluated,
keeping in perspective the amendments mentioned above.
Furthermore, provisions of the Bill, such as the minimum
requirement of Independent Directors and for rotation of
auditors is a fast march toward an investor-friendly India.
The Companies Act, 2013 seems to be opening up new and
simple avenues for mergers, acquisitions and restructuring
operations in India. It is expected that the new legislation
will reduce shareholders’ litigation and propagate their
rights. It endeavors to make restructuring a smooth and
transparent procedure. While it has been a long wait, the law
has taken steps forward to give a new dimension to corporate
restructuring. The Act seeks an alignment with other laws such
as Income Tax and exchange control provisions to facilitate
its efficient implementation. The Rules, which are yet to be
finalized, will also play a crucial rule in this.
We aim to provide you a quick glimpse into key M&A provisions
of the new Companies Act, 2013. Many of its key provisions are
elaborated on in the following chapters, to provide you with an
in-depth understanding on the new rules of the game.
Mergers and acquisitions in the new era of Companies Act, 2013
5
Chapter 2
6
Companies Act 2013:
impact on transactions
Mergers and acquisitions in the new era of Companies Act, 2013
Introduction
The Companies Act, 2013 (2013 Act) has seen the light of
day and replaced the 1956 Act with some sweeping changes
including those in relation to mergers and acquisitions (M&A).
The new Act has been lauded by corporate organizations
and lawyers for its business-friendly corporate regulations,
enhanced disclosure norms and providing protection to
investors and minorities, among other factors, thereby
making M&A smooth and efficient. Its recognition of interse shareholder rights takes the law one step forward to an
investor-friendly regime. While the 2013 Act is appreciated
by many, it poses some practical difficulties for companies in
structuring their transactions.
This article focuses on some of the sections (notified or not
notified), which may have an impact on how M&A transactions
are undertaken and structured in India.
Restriction on multi-layered structures
(not notified)
In the 1956 Act, there are no provisions regarding restrictions
on multi layered structures. Accordingly, several multi-layered
structures have been set up for holding investments in
operating entities to suit business or commercial needs.
However, the 2013 Act has imposed a restriction of two layers
for investment companies. “Investment companies” have been
defined as enterprises whose principal business is acquisition of
shares, stocks, debentures or other securities.
Diagrammatic representation of the provision
Existing
New
Promoter Hold Co
Promoter Hold Co
Group Hold Co
Group Hold Co
Investment No 1
Investment No 1
Investment No 2
Investment No 2
Target Co
Target Co
The requirement mentioned above does not affect
the following:
•
•
A company from acquiring another enterprise that is
incorporated outside India if it has investment
subsidiaries beyond two layers according to the law of the
particular country
A subsidiary company with investment subsidiaries for
meeting statutory requirements
The rationale behind this change could be to limit diversion of
funds and possible tax avoidance through the webs of complex
corporate structures. However, this change could have an
impact on structuring downstream foreign investments through
holding companies in India. Furthermore, the requirement
for demonstration of the operations of subsidiaries leads to
operation- and compliance-related costs.
Furthermore, there is no guidance in the 2013 Act on
determination of the principal business of an investment
company in defining it. This has been the subject of debate
under the legal regime of non-banking financial companies
governed by the RBI. In the absence of any statutory clarity in
this regard, deal structures will need to be looked into carefully
to ensure their compliance with this restriction. Private equity
investors prefer to invest in holding companies to realize
increased returns from the entire group through a single
investment rather than multiple investments in subsidiaries.
This reduces flexibility in structuring investments, and
particularly affects sectors such as infrastructure and mining,
where it is common to have multiple subsidiaries to implement
projects and raise funds. There is no clarity on whether existing
structures will be required to comply with the new regime.
For this provision not to become a deterrent for M&A, the
regulator should consider allowing exceptions for genuine multilayered corporate structures.
Evolution of concept of “control” (notified)
The 2013 Act defines the term control as under:
Control ’ shall include the right to appoint the majority of
directors or control the management or policy decisions
exercisable by a person or persons acting individually or
in concert, directly or indirectly, including by virtue of
their shareholding or management rights or shareholders’
agreements or voting agreements or in any other manner.
Mergers and acquisitions in the new era of Companies Act, 2013
7
The definition in the 2013 Act is broader and seeks to suggest
that a company may control another organization through
other mechanisms as well, e.g., management rights or voting
agreements. The definition of control is closely linked with that
of promoter and provides that a person with control over the
affairs of a company is regarded as its promoter.
The definition of control under the 2013 Act is similar to its
definition under the Securities and Exchange Board of India
(Substantial Acquisition of Shares and Takeovers) Regulations,
2011 (SEBI TOC) and Foreign Direct Investment policy such
that the essential elements among various laws are now
aligned. The definition of control and the jurisprudence
surrounding this under the SEBI TOC has been developed to
protect minority shareholders and provide an exit to them in
the event of change of control.
In light of the similarity in the definition of control under the
SEBI TOC and the 2013 Act, the jurisprudence of control under
the former is likely to be applied under the new Act. However,
the scope of the term control under the SEBI TOC is not clear in
itself. While the Securities Appellate Tribunal (SAT) had decided
that affirmative voting rights granted to investors would not
amount to control due to out of court settlements between the
parties, the Supreme Court has left the question open in its
Subhkam Ventures ruling by stating that the SAT’s order will
not have any precedent value, since Subhkam Ventures did not
appoint its Director on the board and exited most of
its investments.
Deal-making with respect to unlisted companies is likely
to be affected, especially with regard to negotiation of
shareholders’ agreements, due to the prevailing uncertainty
around what constitutes control. Affirmative voting rights
under a shareholder’s agreement can be an effective tool for
safeguarding investments or investors’ interests. Such rights
are negotiated and decided on in shareholders’ agreements,
which are subsequently incorporated into the articles of
association of target companies. Accordingly, investors who
have secured certain rights, which provide them a degree of
control over “management or policy decisions,” either by way
of their representation on boards or their veto rights, may
be regarded as having control of such companies, and can
be classified as promoters, and the Indian companies would
become their subsidiaries for all disclosure purposes.
Careful consideration should be given to obligations and
liabilities associated with the position of a promoter and holding
company (i.e., a related party) under the 2013 Act when
negotiating rights and powers in a company by investors under
the shareholders’ agreement.
8
Recognition of “entrenchment” (not notified)
Another new development in the 2013 Act is its recognition
of entrenchment provisions in the articles of association of a
company. The purpose of shareholder agreements is to secure
certain rights for shareholders, which have not otherwise
been made available to them under the law. For example, an
investor holding 20% shares in a company may want a say in
an alteration of an investee’s articles, which affect its rights in
the company. However, the consent of the investor may not
be required since the law only mandates a special resolution
(three-fourth majority of shareholders present and voting)
for any alteration made in the articles to be approved. In such
a situation, the shareholder agreement may mandate an
affirmative vote of all shareholders for any such alteration to be
approved. While inclusion of such rights has been the norm in
most shareholder agreements, under the 1956 Act, there are
no specific provisions for their entrenchment in the articles of
association of a company, and accordingly, there is ambiguity
around the enforceability of agreements between two or more
persons as regards the share transfers of a public company.
Once clause 5(3) of the 2013 Act is notified, the articles of
a company may have provisions for entrenchment such that
certain specified provisions of the articles may be altered,
although only on the satisfaction of conditions or procedures
that may be more restrictive than those applicable in the case of
a special resolution.
The introduction of entrenchment provisions paves the way
for the use of structures with adequate protection for diverse
groups. Although they can contractually obtain these rights,
incorporating these in their articles of association will make
these more binding.
Acceptability of contractual rights (notified)
It is common practice for transacting shareholders to enter
arrangements involving “put and call” options and other preemption rights including ROFR, tag along /draft along, etc.
While transfer restrictions are enforceable in the case of private
companies, their enforceability in relation to the shares of a
public company has not been established conclusively.
Historically, this practice has been subject to scrutiny, since
such arrangements involving listed and unlisted public
companies were restricted under the Securities Contract
Regulation Act, 1956 (SCRA). The 1956 Act provided
that the shares and any interest in itof a public company
are freely transferable, and therefore, any restrictions on
Mergers and acquisitions in the new era of Companies Act, 2013
the transferability of shares cannot be enforced against it.
Conflicting judgements prevail, leading to further ambiguity.
Clause 58(2) of 2013 Act seems to provide a respite to
such commercial practices and prescribes that a contract
or arrangement between two or more persons in respect of
transfer of securities will be enforceable as a contract.
Furthermore, SEBI and the RBI have issued separate
notifications permitting put and call options on shares, CCDs,
etc., subject to fulfilment of certain conditions.
The amendments mentioned above settle this issue, and
thereby provide legal sanctity or validity of the restrictive rights
of the parties in relation to transfer of securities of a company.
Change in treatment to private companies
and its impact on M&A
Since the overarching theme of the 2013 Act seems to
be protection of minorities, it has resulted in curbing the
flexibilities available to private companies under the 1956 Act.
Various provisions introduced in the statute effectively nullify
the advantages of incorporating a private company over a
public one. Some of these may impact M&A.
Private placement (not notified)
Under the 1956 Act, preferential allotment conditions
were applicable to public or private companies, which were
subsidiaries of public organizations. Under the 2013 Act, these
conditions are also extended to private companies. A special
resolution is required for any preferential allotment of shares,
with the pricing being determined by a registered valuer. In
addition to the above, cumbersome requirements (including
issuance of a private placement offer letter and filings with the
registrar of companies) will have to be adhered to by private
companies, even in the case of standalone placements that
constitute an offer or invitation to offer.
Given that most private companies are closely held, it should
be possible to ensure their uninterrupted operations, except for
the compliance-related requirements that need to be factored
in their transaction timelines.
Differential voting rights (DVR) (not notified)
The 1956 Act permitted a private company to issue shares of
various classes, each of which could have different rights in
terms of dividend, voting or any other special rights, without
needing to satisfy any stipulated conditions, since DVR rules did
not apply to a private company.
As the law stands today, the 2013 Act provides that private
companies will also have to comply with the rules to be
framed by the Government in this regard in order to be able
to issue shares with differential rights. There are concerns
on the validity and enforceability of the differential rights of
the shares of private companies issued under the 1956 Act,
especially since such issuances of shares were not subject to
any conditions.
Restriction on insider trading (notified)
Clause 195 of the 2013 Act captures the essence of SEBI’s
Prohibition of Insider Trading Regulations, 1992, but extends
its applicability to unlisted companies. According to the clause,
no director or key managerial personnel of a company should
engage in insider trading, e.g., subscribing, buying, selling or
dealing in securities, if such a person is reasonably expected
to have access to any non-public, price-sensitive information
in respect of the securities of a company or its procurement
processes, or communicate, directly or indirectly, any nonpublic price-sensitive information to any person. This restriction
is likely to have an impact on deal structuring, since almost
every deal involving an unlisted company involves sharing
of information by directors or key managerial personnel, or
subscription or sale of shares by promoters, who normally
function in an executive capacity within a company.
One possible argument against the applicability of the clause
(mentioned above) for private companies could be that for
the purposes of the 2013 Act, “securities” has the same
meaning as that given to it as in the SCRA, which only applies
to marketable securities and it is a settled position in law that
the securities of a private company are not marketable. One
needs to wait and watch whether this argument will be found
convincing by the regulator. A clarification by MCA would
be useful.
Subsidiary of a foreign company (partly notified)
Section 4(7) of the 1956 Act sets out that a private company,
which is the subsidiary of a foreign company (which if it was
incorporated in India would have been a public company), will
be considered a private company that is a subsidiary of a public
one, and is subject to the same regulatory compliance standards
as that applicable to a public company. Clause 2 of the 2013
Act, through various sub- clauses, attempts to incorporate
section 4 of the 1956 Act. However, there is ambiguity
surrounding the status of subsidiaries of foreign companies in
India. According to the MCA’s general circular No. 16/2013,
dated 18 September 2013, Section 4 stands repealed. This is
a matter that needs clarification, since it will be necessary to
understand the status of a private company incorporated in
India by foreign corporate organizations.
Mergers and acquisitions in the new era of Companies Act, 2013
9
Transfer of undertaking (notified)
Under the 1956 Act, an ordinary resolution of shareholders
was sufficient for public companies to sell/lease or otherwise
dispose of whole or substantially the whole of the undertakings.
However, there is ambiguity regarding the definition of the
terms “undertaking” and “substantially the whole
of undertaking.”
In attempting to define an “undertaking,” the 2013 Act has
introduced the additional restriction of a minimum threshold,
which should not be read independent of the primary
requirement – that the transfer in question is in actuality that of
an undertaking. The 2013 Act defines the following terms as:
•
•
“Undertaking” to mean one in which investment in the
company exceeds 20% of its net worth according to its
audited balance sheet of the preceding financial year or
an undertaking that generated 20% of the company’s total
income during the previous financial year
“Substantially the whole of the undertaking” in any
financial year to mean that 20% or more of the value of the
undertaking according to its audited balance sheet of the
preceding financial year
The shareholders of all companies are required to pass special
resolutions for such disposals, irrespective of whether these are
private or public organizations.
The following illustrations depict the interpretation in relation
to compliance with rules pertaining to special resolutions
being obtained in light of the definitions of “undertaking” and
“substantially the whole of the undertaking” under 2013 Act.
Case 1: Special resolution
A Co has two units, Unit A (generating 80% of its total
income) and Unit B (generating 20% of its total income).
A Co intends to transfer part of Unit B (comprising 20% of
the value of Unit B) to B Co.
A Co.
Unit A
80%
B Co.
Unit B
16%
4%
Based on an initial interpretation of Clause 180 of the
2013 Act, the transfer mentioned above would require a
special resolution in spite of the fact that a part of a unit
of A Co, which generates only 4% of its total income, is to
be transferred.
10
Case 2: No special resolution
A Co has two units, Unit A (generating 81% of its total
income) and Unit B (generating 19% of its total income).
Unit B is to be transferred to B Co.
A Co.
B Co.
Unit A
Unit B
81%
19%
Based on an initial interpretation ofClause 180 of the
2013 Act, the transfer mentioned above does not require
a special resolution in spite of the fact that a unit, which
generates 19% of the total income of A Co, is to be
transferred.
Apart the materiality test mentioned above, which was
introduced in the definition of undertaking, the unit or
part of the unit intended to be transferred will still have
to fulfil the requirement of being an “undertaking.”
In various cases in the past, courts have interpreted
undertakings as the business or activity of companies as
a whole. Furthermore, they have opined that transfer or
sale of shares cannot be interpreted as the transfer of an
undertaking, even if the controlling interest in a company
is transferred or when the shares transferred are the
only assets or a substantial portion of the assets of the
company. The aspects mentioned above have still not
been clarified under the 2013 Act.
It has been seen that a significant number of transactions
typically follow a two-step process wherein the sellers
“push” the business intended to be divested into
subsidiaries, and thereafter sell their shares to potential
investors. In such cases, the first step of transfer of a
business from a holding to a subsidiary may be regarded
as a related party transaction, and there are strict
provisions in relation to consent being obtained through
special resolutions by a holding and a subsidiary. These
will need to comply with the provisions pertaining to
related party transactions once these are notified. This
may have an impact on the flexibility of conducting
transactions involving transfers of undertakings.
This provision has been notified, and therefore,
transactions involving transfer of undertakings are
required, to ensure compliance with the provisions
given above.
Mergers and acquisitions in the new era of Companies Act, 2013
Conclusion
While the 2013 Act is a step in the
right direction for India Inc. and
investors, it may be worthwhile
for the regulators to pay heed to
concerns being voiced by lawyers
and corporate organizations
and incorporate the required
amendments while notifying
rules and issuing clarifications.
Furthermore, the 2013 Act
seeks to align other laws such
as Income Tax and Exchange
Control provisions to facilitate its
efficient implementation. Only
time will tell whether the 2013
Act will be successful in making
M&A easier and more efficient or
be a legislation, which is open to
interpretation, leading to further
disputes and litigation.
Mergers and acquisitions in the new era of Companies Act, 2013
11
Chapter 3
12
Companies Act 2013:
mergers, compromises
and arrangements
Mergers and acquisitions in the new era of Companies Act, 2013
Introduction
•
The Companies Act, 2013 appears to be opening new and
simple avenues for mergers, acquisitions and restructuring
operations in India. While the Act retains the old provisions, it
also adds robust and progressive new ones. Changes made in
it are likely to have a positive impact on the manner in which
corporate structuring is undertaken in India due to numerous
procedural changes.
The 2013 Act seeks to simplify the overall process of
acquisitions, mergers and restructuring, facilitate domestic
and cross-border mergers and acquisitions, and thereby, make
Indian firms relatively more attractive to PE investors. While
some of the changes to look for at the conceptual level include
merger/demerger processes, cross-border and fast track
mergers between small companies and holdings, subsidiaries
and provisions relating to minority shareholders’ protection
and exits, among others, a lot still needs to be done in terms
of provision of increased clarity on some critical areas and the
overall interplay of the 2013 Act with other laws.
However, pending notification of the sections and rules in
relation to restructuring and absence of transitional provisions
has led to concern within industry and professionals engaged in
restructuring in the corporate world. The 2013 Act provides for
the constitution of the National Company Law Tribunal (NCLT)
as the single authority for all schemes relating to restructuring.
However, there is no clarity on the time that will be taken for
the NCLT to be constituted and become operational. Practical
difficulties are expected in implementation of provisions
relating to restructuring till the MCA provides clarity on
these issues.
This article looks at some key provisions relating to mergers,
compromises and arrangements in the 2013 Act and provides
a quick impact analysis of these.
A. Fast-track merger (“short form” mergers)
As in some overseas jurisdictions, the 2013 Act has introduced
the new concept of fast- track mergers and demergers. These
provide the option of a simplified and fast-track merge/
demerger process, which can be
Holding Co.
used for the following and is an
option for companies:
•
Merger of two or more
specified small companies1
Merger
100%
•
Merger between holding company and its wholly
owned subsidiary
Such other classes of companies as may be prescribed
In this case, the merger will have to be approved by Central
Government and there will be no requirement to approach
NCLT.
Approval process
Under this process, the schemes approved by the boards of
directors of companies will need to be sent to the Registrar
of Companies (RoC) and the Official Liquidator (OL) for their
suggestions or objections within 30 days. The scheme will then
be considered in the meetings of shareholders or creditors,
along with their suggestions or objections, and will have to be
approved by the following classes of persons:
•
•
Shareholders holding 90% of the total number of shares at
a general meeting
Majority creditors (representing nine-tenth in value) in a
meeting convened with 21 days’ notice
Currently, under the 1956 Act, the criterion of “present
and voting” is essential for the conduct of shareholders’ and
creditors’ meetings. However, the similar concept of “present
and voting” has not been included in the 2013 Act, and there is
no clarity on whether voting through a postal ballot will now be
an acceptable mechanism. This requires clarity from
the Ministry.
After the approval mentioned above, the scheme will have to be
filed with the OL, RoC and the Central Government. In the event
of there being “no objection,” this will be deemed as approved.
However, in the event of objections from the RoC or OL, the
scheme may be referred by the Central Government to the
NCLT for it to consider the scheme under the normal process
of a merger. In this case, the NCLT can either mandate that the
scheme is to be considered a normal merger or it may confirm
the scheme by passing an order to this effect. Therefore, a
company is at risk of the process being considered a normal
merger process instead of a fast-track merger.
In addition to the above, both the companies (transferor and
transferee) will need to file a declaration of solvency with
the RoC.
WOS
1 A small company is a private company that meets either of the following requirements:
• Its paid-up capital does not exceed INR5 million (or higher amount, as may be prescribed, and should not be more than INR 50 million).
• Its turnover (according to its last profit and loss account) does not exceed INR20 million (or a higher amount, as may be prescribed, which will not be more than
INR200 million).
Mergers and acquisitions in the new era of Companies Act, 2013
13
Among the various features of fast-track mergers of companies,
one is the exemption from the need to obtain auditors’
certificates of compliance with applicable accounting standards.
This is a welcome step that will result in reduction in the
administrative burden, timelines and costs of smaller companies
that fall within threshold limits. However, on the flip side, there
is no clarity on whether fast-track mergers will be allowed prior
to NCLT becoming operational. Moreover, under existing tax
laws, there is no need for a company to seek the approval of
a court to prove the tax neutrality of a merger or demerger.
However, clarity in this regard will be required in the case of fast
-track mergers involving non-court approved schemes
flexibility. Cross-border mergers could have ground-breaking
significance in plotting India on the global M&A landscape,
since corporate deals have fallen through or failed to meet their
desired objectives in the past due to the lack of such provisions
in the 1956 Act.
Enabling of cross-border mergers is expected to help Indian
companies in more ways than one, including in the following:
•
•
•
B. Cross-border mergers
With businesses no longer limited by borders, cross-border M&A
transactions present significant opportunities for economic
gain and increased shareholder or investor value. Various
factors influence the spurt in recent cross-border mergers and
acquisitions, including the ever-increasing need of companies to
tap new markets and set up global operations in these, achieve
cost reduction and synergies and secure natural resources.
Cross-border M&A is also supported by technological
advancements, low cost financing arrangements and robust
market conditions, which have made deal-makers confident and
think more creatively about their global growth strategies.
The flow of transactions could be inbound (non-residents
investing in India) or outbound (Indian businesses making
investments abroad).
Overseas
Current laws only permit
jurisdiction
inbound mergers (foreign
Outbound
Inbound
companies merging with
Merger
Merger
Indian ones) and not the
other way round. The 2013
Indian
Act proposes to allow both
Company
— inbound and outbound
cross-border mergers between Indian companies and foreign
ones. It provides for the merger of an Indian company into
a foreign one, whether its place of business is in India or in
certified jurisdictions (to be notified by the Central Government
from time to time), subject to the NCLT’s and RBI’s approval.
The consideration of a merger, which will also be subject to
the approval of the RBI, could either be in cash or depository
receipts, or partly in cash and partly in depository receipts2. The
provisions mentioned above could have a far-reaching impact
that will facilitate cross-border transactions and increase their
Restructuring their shareholdings, wherein they can
migrate ownership to an international holding structure
Facilitating listing of entities, which may have Indian assets
in overseas jurisdictions
Providing exit routes to current investors in overseas
jurisdictions
However, corresponding amendments are required in
existing laws including the Income Tax Act, Exchange Control
Regulations (relating to ownership of real estate in India,
sectoral caps, definitions of overseas holdings, etc.), securityrelated laws (change in rules regarding dual listings), etc.
Currently, tax laws do not provide any tax-neutral provisions
to enable such cross-border mergers. The debate on whether
cross border mergers should be taxable or not is an interesting
one, since in some mergers, companies may be moving some
value outside India. If they are operating companies, they will
need to move out their Indian operations before the mergers, to
avoid operational and tax-related complications. Furthermore,
the impact of payment of cash/depository receipts or any other
modes on the tax neutrality of the amalgamations will need
deep analyses.
A key aspect to look for will be notification of the “specified
jurisdictions” for cross-border mergers and the amendment of
Exchange Control Regulations. This may restrict the scope of
outbound mergers as well as inbound ones, which are currently
allowed from any jurisdiction that allow cross-border mergers
under their domestic laws. Moreover, the requirement of
approval from the RBI is expected to play a major role in such
cross-border mergers.
C. Demergers defined
The draft rules released by the MCA clarify that the term
“demerger” is to be included within the compromise or
arrangement defined in the 2013 Act. As opposed to the 1956
Act, the Rules provide a clear definition of the term. It defines
a demerger in relation to companies and includes transfers,
2 For this purpose, depository receipts are defined as any instrument in the form of a depository created by a domestic company in India and authorised by one
incorporated outside India, which is making an issue of such depository receipts.
14
Mergers and acquisitions in the new era of Companies Act, 2013
pursuant to the scheme of arrangement by a “demerged
company” of one or more undertakings to any resulting
company in such a manner as provided in section 2(19AA)
of the Income Tax Act, 1961 (IT Act), subject to it fulfilling
the conditions stipulated therein and shares allotted by the
“resulting company” to the shareholders of the demerged
company against transfer of its assets and liabilities.
Furthermore, the Rules provide for the accounting treatment
for the demerger till a specific accounting standard has been
prescribed for it, which is in accordance with the conditions
stipulated in section 2(19AA) of the IT Act. The rules prescribe
that the difference in the value of assets and liabilities in the
books of a demerged company will be credited to its capital
reserve or debited to its goodwill. Moreover, the difference in
the net assets taken over and shares issued as consideration will
be credited to the capital reserve (excess) or debited to goodwill
(deficit) in the books of the resulting company. As compared to
the IT Act, which ignores revaluation of assets for the purpose
of determining book value, the rules of the 2013 Act enable
a company to ignore any revaluation or write- off of assets,
only of the preceding two financial years. A certificate from
a Chartered Accountant will also be required to be submitted
to the NCLT to the effect that the accounting treatment is in
compliance with the conditions so prescribed.
Although the rules are at the draft stage as of date, one can
look for guidance for accounting for demergers in them. The
rules give clarity to the way forward for them. This is expected
to restrict alternative accounting methodologies used in the
past by corporate organizations in the past to account for
reserves arising due to demergers within the scheme.
D. Treasury shares
Indian promoters of companies, including listed ones, have in
the past used the route of issuing treasury stocks to consolidate
their holdings in companies to raise funds and as an avenue
to control voting rights. Promoters have followed the practice
of transferring the shares of their subsidiary companies to
trusts and issuing shares of holding companies pursuant to
the mergers of wholly owned or partially owned subsidiaries
with holding companies, instead of canceling such shares.
Past precedents include Escorts, Mahindra & Mahindra and
Jaiprakash Associates.
However, the 2013 Act restricts a transferee company from
holding shares in its own name or in the name of a trust. Any
inter-company investments between companies involved in
mergers need to be mandatorily canceled in this event.
The provisions given above should result in greater
transparency and reduce the scope of unconventional or
ambiguous practices, particularly where valuation and
accounting considerations are involved. This change is also in
line with the 1956 Act, which prohibits a company from owning
its own shares.
A related concern is how treasury stock holdings already
created under the 1956 Act will be treated in the future —
whether they can continue in the same manner or they need to
be unwound.
E. Mergers of listed companies with unlisted ones
The 1956 Act does not contain any specific provision governing
the merger of a listed company with an unlisted one. It is
generally assumed that shares issued pursuant to the merger
of a listed company with an unlisted one (or vice versa) need to
be listed on the stock exchanges where the transferor company
was listed. There have been cases, even in the present scenario,
where the resulting company has continued to be unlisted
after the demerger. Recent precedents include the schemes of
demerger of Wipro Ltd. and Sundaram Clayton Ltd.
The 2013 Act sets out formal guidelines and provides an option
to a transferee company to remain unlisted till it is listed or
applies for listing, provided the shareholders of the merged
listed company are given an exit opportunity. It also provides
that provision should be made by the NCLT for an exit route for
the shareholders of a transferor company who decide to opt out
of the transferee company by making payment amounting to
the value of the shares and other benefits, in accordance with
a pre-determined price formula or after a valuation report is
produced (which should not be less than the value prescribed by
SEBI’s regulations).
An analysis of the new provisions brings to light attempts made
to codify the existing practice while providing more clarity
on valuation requirements. While, prima facie it seems that
shareholders deciding to opt out can exercise this option even if
the transferee company is listed, this requires lucidity.
A specific provision in the 2013 Act will encourage companies
to explore this option as an alternative or in addition to the
Delisting Guidelines. It will be interesting to see the interplay
between SEBI’s delisting regulations (and revisions, if any)
and these provisions, especially in light of the requirements of
delisting regulations, where minority shareholders effectively
determine their own exit price (which is generally at a
significant premium). One would expect the provisions between
SEBI and MCA to be aligned while coming into force.
Practical questions may also arise on the applicable date for
valuation of shares (e.g., the appointed date, the effective date,
etc.) and procedures for compensating shareholders if the
NCLT process consumes considerable time. Further clarity will
Mergers and acquisitions in the new era of Companies Act, 2013
15
scheme should be sent to the Central Government (i.e.,
the Regional Director, Registrar of Companies (ROC), the
Official Liquidator (OL), Income Tax authorities, the RBI,
SEBI, the Competition Commission of India (CCI) and other
sectoral regulators for their comments/ suggestions/
objections within 30 days. In case no representation is
made within 30 days, it will be presumed that they have
approved the scheme. Although the relevant section has
not been notified, the MCA is taking steps to increase
the role of other authorities in implementation of such
schemes. In a recent circular, the MCA has clarified that
the RD will invite specific comments from the Income Tax
department within 15 days of receipt of the notice before
filing his response to the Court. Furthermore, the RD will
also consider the feedback required from any sectoral
regulator if it appears necessary to him. Additionally,
the Bombay High Court (in its recent order) gave specific
instructions and detailed timelines to be followed during
the RD process after admission of a petition, restricting the
timeline from the date of service of petition on the RD to
the date of filing of an affidavit by the RD in the High Court.
However, whether the other jurisdictional High Courts
adopt a similar approach is a wait and watch game.
also be required in the event of any dispute on the exit price
determined on the basis of the valuation (e.g., where SEBI’s
price is not a true reflection of the true intrinsic value of a listed
company) and the redressal mechanism for such disputes.
Capital gains and other tax implications in the hands of exiting
shareholders, the tax neutrality of the scheme of arrangement
(if more than 25% of the shareholders opt for the exit route),
etc., will need to be evaluated prior to corporate organizations
following this route.
F. Minority buyout
The 2013 Act has introduced an exit mechanism for minority
shareholders with the intent of reducing litigation with minority
shareholders. The Act grants access to the acquirer or person
acting in concert or a person or a group of persons becoming
registered shareholders of 90% or more of the issued equity
share capital of the target company (listed or unlisted) by virtue
of amalgamation, share exchange, conversion, securities or
for any other reason. Such an acquirer, person or a group of
persons will notify minority shareholders about their intention
of buying the remaining equity shares. In addition, minority
shareholders may also offer their shares suo- motto to
majority shareholders.
•
As provided in the draft rules, the price mechanism for the
minority buy-back in the case of a listed company will be the
price according to SEBI’s regulations, but this needs to be
carried out by a registered valuer. Whereas, for an unlisted
company, various factors are taken into consideration, i.e., the
highest price paid for an acquisition during the last 12 months
and the fair price of shares to be determined after taking into
account valuation parameters as prescribed. In addition, an
registered valuer will provide a valuation report to the board of
directors of a company, justifying the methodology of arriving
at such a price. On the other hand, the shares of minority
shareholders need to be acquired by majority shareholders and
not by the company and will entail outflow of funds in the hands
of the majority shareholders.
The provisions virtually recognize minority squeeze out
as a legal option. This has been undertaken by corporate
organizations through various corporate restructuring means in
the past. However, there is not much clarity on whether this is a
mandatory exit mechanism and a scenario where one minority
shareholder desires to exit would the acquirer be forced to buy
out all.
G. Other key changes to the process of
compromise or arrangement
•
16
•
The 2013 Act envisages a paradigm shift in the process of
compromise/arrangement. It envisages that all the powers
and functions of the Company Law Board, Company
Court BIFR under the Sick Industrial Companies Act will
henceforth be exercised by the NCLT. Establishment of a
single forum, which is dedicated to corporate matters, is
a welcome move, and removes the problem of multiple
regulators. However, setting up of such quasi-judicial
tribunals has been a constant point of litigation, either
on its legal competence or non-compliance with the
provisions of the NCLT with the principles laid down in the
past Apex Court ruling. A recent petition filed in the Apex
Court (against the formation of the NCLT) has delayed the
process of recruiting judicial and technical members of
the NCLT, which could mean further deferral in setting up
of the NCLT, which found its way into the 2013 Act after
almost a decade of a legal battle.
Furthermore, with a view to reduce the timelines involved
in a restructuring exercise, the 2013 Act has introduced
a minimum threshold for raising objections to the
scheme of arrangement, i.e., only persons holding a 10%
shareholding or with a minimum outstanding debt of 5%
can object to the scheme. These limits may be considered
high, especially in the case of listed companies, where the
minority would need to commit substantial effort in pooling
stakes if they are to raise valid objections, unless a large
The 2013 Act provides that a notice for a meeting for the
Mergers and acquisitions in the new era of Companies Act, 2013
institutional shareholder takes up the cause. However,
it provides a safeguard against frivolous litigations by
shareholders with negligible stakes (which happens in
many schemes), thereby avoiding unnecessary delays.
•
•
The 2013 Act also empowers the NCLT to dispense with
meetings of creditors if at least 90% of the creditors
in value agree and confirm this by affidavit, thereby
reducing the discrepancy in practice followed by different
High Courts while granting their approval on the basis of
consent letters obtained. However, there is the absence of
an explicit provision for dispensation from shareholders’
meetings.
The 2013 Act also requires the valuation report for the
share swap ratio to be sent along with the notice for the
meeting to all stakeholders, as is currently applicable to
listed companies, thereby opening doors for larger scrutiny
on the share swap ratio by shareholders, even in the case
of unlisted companies.
The road ahead
The 2013 Act provides that until the Government notifies a
date for transfer of all matters, proceedings or cases sent to
the NCLT, the provisions of the Act in regard to the jurisdiction,
powers, authority and function of the current Company Law
Board and the Company Court will continue to apply. The 2013
Act does not provide for any transitional provisions to govern
the restructuring in progress at the time of notification of such
a date.
Furthermore, if the restructuring currently ongoing under the
1956 Act is to be continued under the 2013 Act, any nonconformity of the portion of the process completed under the
1956 Act with the provisions of the 2013 Act is a question
that remains unaddressed. For example, an ongoing scheme of
a merger envisages the creation of treasury stock, would this
need to be deleted, and the swap ratio to be reworked if the
relevant section governing treasury stock becomes effective
prior to the final sanction of the scheme by the court.
The implementation of the 2013 Act will also require updates
in other laws to link these with the new provisions. Laws
including Stamp Duty (the conveyance rate provided for orders
under section 391–394 of the 1956 Act), Exchange Control
regulations (for holding of real estate, sectoral limits, etc.) and
tax laws (definition of mergers, demergers and other conditions
for tax neutrality) will need amendments prior to notification of
sections relating to merger provisions, to provide the effect of
benefits envisaged by the 2013 Act.
Conclusion
To conclude, the overall impact of the
2013 Act on mergers, compromises and
arrangements is to introduce certain
simplistic and forward-looking concepts, and
also codify in law certain concepts (such as
dispensation, statutory auditor certificates
and demerger accounting), which were
followed in practice, put not contained in
law. As of now, the full impact of the law is
not very clear, since many matters will be
governed by rules, which will be formalized
once feedback from stakeholders is received
by the MCA and incorporated in the final
rules to be issued.
On the whole, the 2013 Act is a step
toward bringing greater transparency and
accountability in the age-old procedures
of M&A, thereby visibly making the Indian
Corporate Law relatively friendlier and more
acceptable in the global arena.
Mergers and acquisitions in the new era of Companies Act, 2013
17
Chapter 4
18
Companies Act 2013:
capital structuring and
other M&A related aspects
Mergers and acquisitions in the new era of Companies Act, 2013
The capital structures of companies have drastically changed
over the years with the innovation and introduction of a new
class of financial instruments and securities. Earlier, companies
were mainly funded and managed by small groups of known
individuals. In contrast, today, raising funds from external
sources to expand the business has become a norm. Most
businesses run by major business houses have entered various
diversified businesses through their divisions, subsidiaries
and other associated entities. Capital structuring has become
essential in order to raise capital for diversified businesses and
to improve the returns.
The Companies Act, 1956 (Old Cos Act) was drafted in an
era where the size and structure of business organizations of
today was a distant dream. Therefore, the complexity of the
transactions being entered was not foreseen by the Old Cos
Act. With the advent of the Companies Act, 2013 (New Cos
Act), the Ministry has tried to set guidelines and govern these
ever-growing entities by bringing domestic legislations at par
with those practiced around the world.
There are two basic forms of capital — equity and debt capital.
Furthermore, variations are possible, based on the commercial
understanding between the borrowers and the lenders in the
form of compulsorily convertible debentures or preference
shares, hybrid instruments, etc. Each financial instrument
has its own benefits and drawbacks, and a substantial portion
of management time is invested in designing appropriate
capital structures in terms of the risk or reward payoff for
stakeholders. The methods to achieve the appropriate capital
structure often result in management resorting to strategies
such as private placements, buyback, capital reduction
and issuance of bonus shares, which have their own set of
implications or considerations. This article captures some of the
key amendments that have been brought in by the New Cos Act
in relation to capital structuring and related aspects including
buyback of shares, issue of bonus shares, capital reduction
and others.
Buy-back of shares3
Buy-back refers to purchase of its own shares by a company
from its existing shareholders. This is generally undertaken by
a company when it has a significant amount of cash, there are
no viable projects on the table and it is interested in disbursing
cash to its shareholders in the form of dividends. The way out
for management is buying back its own shares. Buy-back may
also be undertaken for other reasons such as maintaining the
market price of shares, an increase in promoters’ stakes, etc.
Buy-back may be of the following types:
•
•
•
Buy-back of up to 10% of total paid-up capital plus free
reserves approved by the board of directors
Buy-back of up to 25% of the total paid-up capital plus
free reserves approved through a special resolution at the
general meeting of the company
Buy-back through a court-approved Scheme
of Arrangement
Under the Old Cos Act, a buy-back approved by a board of
directors was only possible after a period of 365 days had
lapsed from the date of the preceding buy-back offer. As
regards a buy-back approved by shareholders, it was possible
to adopt a view that multiple buy-backs were permissible in the
same financial year as long as the total buy-back in that specific
year did not exceed 25% of the paid up equity capital of the
The mandatory “cooling off” period of one
year between buybacks limit use of buyback as a capital repatriation strategy.
company. However, the New Cos Act has curtailed this freedom
offered to companies by mandating maintenance of a gap of at
least one year between two buy-backs under any of the routes.
Furthermore, buy-back of shares undertaken as part of a courtapproved Scheme of Arrangement will also need to adhere to
conditions prescribed under buy-back provisions. The Old Cos
Act prohibited a company from undertaking buy-back if it had
defaulted in repaying deposits, redeeming preference shares
or debentures, paying dividends, etc., till the time default
persisted4. However, under the New Cos Act, a company that
has defaulted (as above) is prohibited from buying back
its shares for a further period of three years after the default
is remedied.
Capital reduction5
“Capital reduction,” a commonly used tool for increasing
shareholder value and realigning capital structure, has also
been subject to certain stringent provisions under the New
Cos Act.
3 Section 77A in Old Cos Act and Section 68 in New Cos Act
4 Conditions detailed in section 77B of Old Cos Act and section 70 of New Cos Act; section partly notified by the Ministry
5 Section 101-105 of Old Cos Act and Section 66 of New Cos Act
Mergers and acquisitions in the new era of Companies Act, 2013
19
The New Cos Act, emphasising on the importance of repayment
of deposits accepted by a company from the public, prohibits
an organization with arrears in its payment of deposits or
interest on such deposits (accepted either before or after
commencement of the New Cos Act) from undertaking capital
reduction.
The procedure for undertaking capital reduction has been
made more onerous by mandating the NCLT6 (which receives
applications from companies undertaking capital reduction) to
forward these to the Central Government (CG), the Registrar,
SEBI (in the case of listed companies) and creditors, and take
into consideration representations made by them. The CG and
others are required to make their representations to the NCLT
within a period of three months from the date of receipt of
notice, failing which their assent will be presumed.
The requirement of approaching
all interested parties, coupled with
procurement of auditor’s certificate before
intended capital reduction, may increase
overall timelines, but will ensure that the
rights of all stakeholders are protected.
Furthermore, submission of a certificate from a company’s
auditor, confirming that the accounting treatment for such
reduction is in conformity with the specified Accounting
Standards, has been made a pre-requisite for seeking the
NCLT’s approval of the capital reduction scheme.
Additionally, it has been made mandatory for a company to
publish the order of the NCLT sanctioning capital reduction in
the manner directed.
Variation of shareholders’ rights7
The provision with respect to a variation in shareholders’ rights
under the New Cos Act has undergone little change vis a vis
the Old Cos Act. Provisions seeking the written consent of at
least three-fourths of the class of shareholders, whose rights
are being affected, or by way of a special resolution passed at
a separate meeting of such a class of shareholders are here to
stay, with the additional requirement of seeking consent from
at least three-fourths of such other classes of shareholders if
variations in the rights of one class of shareholders affect the
rights of any other class of shareholders.
Issue of shares with differential voting
rights (DVR)8
An alternative to variation of shareholders’ rights is issue of
DVR shares, which are like ordinary equity shares, but are
different in that they provide the shareholders fewer voting
rights than those of ordinary shareholders. A company can
issue DVR shares (not exceeding 25% of its share capital),
only if it has been profitable for three years preceding the
year in which it has decided to issue DVR shares, and it has
not defaulted in filing its annual accounts and returns for
the period. Furthermore, the articles of a company should
authorize issue of DVR shares or the company should have
This will have an impact on the flexibility
hitherto enjoyed by private companies to
structure their capital.
obtained its shareholders’ approval in a general meeting by
passing a special resolution (by postal ballot in the case of listed
companies) for issue of such shares.
Under the Old Cos Act, restrictive conditions relating to issue
of DVR shares were not applicable to private companies unless
these were subsidiaries of public companies. A private company
was free to issue shares with DVR, in accordance with the
regulations specified in its articles of association. However,
the New Cos Act has widened the purview of the provisions to
all companies, thereby securing within its scope issue of DVR
shares, even by private companies.
Issue of bonus shares9
The Old Cos Act does not have any specific provision that
deals with the issue of bonus shares, although the concept of
bonus shares is referred to at many places. This led to varying
practices followed by companies for issuance of bonus shares.
However, the New Cos Act has introduced a section (with a view
6 The New Cos Act, in order to provide swifter ruling in cases related to companies, proposes setting up of the National Company Law Tribunal (NCLT), which will
assume jurisdiction of the High Court on corporate law-related matters.
7
Section 106-107 of Old Cos Act and Section 48 of New Cos Act
8
Section 85-86 of Old Cos Act and Section 43 of New Cos Act
9
No provisions for issue of bonus shares in Old Cos Act, governed by section 63 of New Cos Act
20
Mergers and acquisitions in the new era of Companies Act, 2013
to bringing about uniformity),which permits a company to issue
fully paid-up bonus shares.
In the case of listed entities, SEBI’s Issue of Capital and
Disclosure Requirement regulation, 2009 requires that a
bonus issue is made from free reserves built from genuine
profits or share premium collected only in cash and prohibits
capitalization of revaluation reserves. Furthermore, the
Institute of Chartered Accountants of India (ICAI), in its
guidance note on “Availability of Revaluation Reserve for Issue
of Bonus Shares,” states that a company is not permitted
to issue bonus shares out of the reserves it has created by
revaluation of its assets. Similar requirements are also included
in Accounting Standard 10 issued by ICAI.
Recently, the RBI permitted Indian
companies to inter alia issue bonus
redeemable or non-convertible preference
shares from their general reserves under
a scheme of arrangement to non-resident
shareholders. This, coupled with the
provision enacted under the New Cos Act,
are forward-looking provisions that will find
favor with investors.
The New Cos Act, walking the line set by the guidelines
mentioned above, has incorporated a new section, which
provides for issue of fully paid-up bonus shares out of its free
reserves, or its security premium account or capital redemption
reserve account, subject to compliance with certain conditions
such as authorization by the articles, approval provided in
a general meeting, etc. Furthermore, companies have been
prohibited from issuing bonus shares by capitalizing on their
revaluation reserves or in lieu of dividends.
Private placement10
The New Cos Act formally introduces the concept of private
placement, which, under the Old Cos Act, was conducted
with the support of various provisions. Under the New Cos
Act, “private placement” has been defined to mean any offer
of securities or an invitation to subscribe to the securities
of a select group of persons by a company through issue of
a private placement offer letter, which satisfies prescribed
conditions. These provisions are applicable for private and
public companies. Any offer that is not in compliance with this
clause will be deemed a public offer and applicable provisions
applicable will apply to it.
The New Cos Act provides that an offer of private placement of
securities can be made to a maximum of 50 persons or a higher
prescribed number in a financial year (the Draft rules prescribed
a limit of 200 persons in a financial year). However, qualified
institutional buyers, as defined under SEBI’s Issue of Capital and
Disclosure Requirement and employees under the Employees’
Stock Option Scheme, have been excluded while computing
the maximum limit. The Draft rules also prescribe limits on
the number of private placements that can be made in a year
and intervals between each such placement. As in the case of
public offers, a company can only collect subscriptions through
cheques, demand drafts or banking channels and should keep
these in a separate bank account.
A direct consequence of the recent dispute between the Sahara
Group and SEBI has been a clarification that an offer should
only be made to persons whose names have been recorded
by a company prior to inviting subscriptions. Furthermore,
a company making an offer or issuing an invitation through
private placement will need to allot its securities within 60 days
from the date of receipt of the application money, failing which
this will need to be repaid to the subscribers.
Considering that private placement by
private companies can be made to a large
number of investors, many unlisted public
companies may consider becoming private.
Furthermore, tightening the noose on companies for raising
funds in a fraudulent manner, the New Cos Act states that no
fresh offer or invitation can be issued unless their allotments
with respect to previous offers or invitations have been
completed, withdrawn or abandoned by them. Moreover,
companies raising funds through private placement will not
be allowed to release any public advertisements or utilize any
media, marketing or distribution channels or agents, to inform
the public about such offers.
10 Section 67 of Old Cos Act and Section 42 of New Cos Act
Mergers and acquisitions in the new era of Companies Act, 2013
21
Loans to directors/subsidiaries11
Companies’ loans and investments12
Taking note of misuse of rules relating to loans advanced
to directors and persons in whom directors are interested,
the New Cos Act mandates stringent regulations relating to
advance of such loans and levies a heavy penalty in the case of
non-compliance.
Like the existing Old Cos Act, the New Cos Act also prohibits a
company from giving loans or guarantees to, providing security
in connection with a loan to any other body corporate or
acquiring the securities of any other body corporate exceeding
the higher of the following:
The New Cos Act has withdrawn the exemptions available to
private companies under the Old Cos Act in this regard, thereby
making it nearly impossible for directors to divert funds for
their personal use by such means. This provision is among the
few sections that has been notified by the Ministry.
a) 60% of its paid-up share capital, free reserves and
securities premium
Under the Old Cos Act, such loans or guarantees could be
provided with the approval of the Central Government. The New
Cos Act has taken away this shield from companies. However,
exceptions have been made in the following situations:
1. Loans to managing or whole-time directors as part of
service conditions committed to him or her or in pursuance
of schemes approved by companies’ shareholders through
special resolutions
2. Loans or guarantees provided in the ordinary course of
business by a company and the rate of interest on such
loans not being less than the bank rate declared by the RBI
The New Cos Act includes restrictions on advancing of loans
or guarantees to directors and “to any other person in whom
a director is interested.” The expression “any other person in
whom a director is interested” includes any body corporate,
whose board of directors, managing director or manager acts in
accordance with the directions or instructions of the board or of
any director of the lending company. A literal reading suggests
that this expression may cover subsidiary companies.
It may be noted that the Old Cos Act had specifically exempted
any loans or advances granted to wholly owned subsidiaries
from applicable restrictions. This exemption has been removed
under the New Cos Act, which seems to suggest that loans
cannot be advanced to subsidiaries that do not have completely
independent management. If this view is correct, it is likely
to create significant hardship for many companies, especially
where support of a holding company is sought as a prerequirement by lending institutions.
b) 100% of its free reserves and securities premium
Under the Old Cos Act, the restriction above was only
applicable in connection with provision of loans/guarantees/
securities on behalf of another body corporate. The New
Cos Act extends this restriction to any person or entity.
Furthermore, prior approval through a special resolution
passed at a general meeting is mandated where the specified
limits given above are likely to be breached.
The loans/guarantee/security provided by private companies
or holding company to/on behalf of its wholly owned subsidiary
have also been brought under prescribed investment
limits under the provisions of the New Cos Act. This will
create hardships for many subsidiary companies, which are
significantly dependent on their parents for financing. In
many cases, loans given by parents to their subsidiaries are
substantial and may breach the 60% or 100% limits when the
New Cos Act is effective.
A company will now be required to make
full disclosure of such loans/guarantees/
securities and the purpose of their
utilization by the recipient in its financial
statements.
Additionally, the New Cos Act requires a lending company
to charge interest on a loan advanced, the minimum
rate whereof has been linked to the prevailing yield on
government securities.
A clarification from the Ministry of Corporate Affairs on this is
eagerly awaited by India Inc. in view of the ambiguity relating to
loans advanced to subsidiaries.
12 Section 372A of Old Cos Act and Section 186 of New Cos Act
22
Mergers and acquisitions in the new era of Companies Act, 2013
Revival and rehabilitation of
sick companies13
Over the years, corporate legislation in India has been criticised
for not addressing the concerns of creditors. One of the key
changes brought about by the New Cos Act is simplification of
the procedure for rehabilitation and winding up of
sick companies.
The coverage of the Sick Industrial Companies Act, 1985
(SICA) is limited to industrial companies, while the New Cos
Act covers the revival and rehabilitation of all companies,
irrespective of their sectors. The criterion for erosion of 50%
of a company’s net worth for declaring it sick and approaching
the Board for Industrial and Financial Reconstruction has been
dispensed with in the New Cos Act – the revised criterion is
“inability to pay 50% of the outstanding secured debt” within
30 days of service of notice by secured lenders. Any secured
creditor fulfilling the criteria given above or a company may
suo moto file an application with the NCLT for being declared a
sick organization on the same grounds.
Correlation of its sickness with a company’s
inability to pay debts rather than erosion of
its net worth, which in most cases is subject
to accounting vagaries, would find favor
with stakeholders.
On being assessed as a sick company, the creditor or company
may file an application with the NCLT to determine measures
to be adopted for its revival or rehabilitation. The scheme of
revival and rehabilitation will need to be approved by secured
creditors (holding a 75% value) and unsecured creditors (holding
a 25% value). If this is not approved, the NCLT can order the
company to be wound up.
Conclusion
While some conditions for regulation of capital
structuring, including offers of securities
made by private companies, are warranted
in view of some recent cases, the current set
of regulations seem too cumbersome and
restrictive, especially for private companies.
On the other hand, this ensures discipline and
corporate governance, which appear to be the
need of the hour.
13 Revival and rehabilitation of Sick Industrial companies was earlier governed under the Sick Industrial Companies Act, 1985 and is now covered under Chapter XIX of
New Cos Act.
Mergers and acquisitions in the new era of Companies Act, 2013
23
Date
Notes:
24
Mergers and acquisitions in the new era of Companies Act, 2013
Date
Mergers and acquisitions in the new era of Companies Act, 2013
25
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